Income Tax and Social Security Benefits

Upon receiving a favorable decision in your claim for Social Security benefits, it is the natural tendency for claimants to breathe a sigh of relief and start planning how to spend the award money. Maybe past due bills will finally be paid off; or perhaps an item of necessity that has long been needed will finally be purchased. It can be a liberating feeling knowing that, at long last, monetary help is on the way. But before claimants commence spending their award, it is imperative for them to understand certain tax implications so potential problems with the IRS down the road can be avoided from the onset.

            First, the claimant must determine whether they were awarded benefits under the provisions of Title II Supplemental Security Income (SSI), Title XVI Disability Benefits, or both. The reason for this is that SSI benefits are not subject to income tax.

            If the claimant has received disability benefits under Title XVI, they then must determine how much their “provisional income” is. Simply put, provisional income is the sum of any gross income earned, tax-exempt interest, and one-half of Social Security benefits. If the provisional income is greater than $25,000 for single taxpayers or $32,000 for married taxpayers filing jointly, then up to 50% of Social Security benefits are taxable. Now it is important to be aware that this does not mean that 50% of Social Security benefits will be taken in tax. Rather, the meaning is that one half of the benefits received are subject to being taxed. Most recipients of disability benefits will fall into this category.

            There is a second tier of income tax, however, which can reach up to 85% of Social Security benefits received. This situation applies only to (1) single taxpayers with provisional income over $34,000; (2) married taxpayers filing jointly with provisional income over $44,000; and (3) all married persons who file separate returns, but do not live apart.

            Receivers of Social Security Disability benefits finally must be mindful of the tax implications of the retroactive lump sum payments they may receive. Congress has recently enacted a law through which claimants may elect to utilize a tax exemption for each year retroactive benefits were received up to a certain “base amount”. In most cases, claimants would be well served to utilize this special tax exemption as it will both reduce the amount of taxes owed and eliminate the need to amend prior returns.

            Of course, claimants may wonder how they will know exactly how much of the benefits received in the lump sum was payment for prior years. The answer is that claimants will receive an SSA-1099 from the Social Security Administration by February 1 of the year following the award decision. This form will break down the award by year as well list any attorney’s fees paid out of the award. It is a good idea, however, for the claimant to compare this form to the award letter they have already received to make sure there are no errors in the 1099.

            Finally, please note that the above information is provided as general guidance for claimants receiving Social Security disability benefits and is not intended to constitute tax advice in any particular case.